Bulletin

SEC too focused on stats, inspector says

Agency says it’s improved coordination after Stanford case

By

RonaldD. Orol

WASHINGTON (MarketWatch) — The Securities and Exchange Commission is still focused too much on the number of cases it has brought and not enough on the number of investors protected, the agency’s inspector general charged Wednesday at a hearing looking into the commission’s failure to identify quickly an $8 billion fraud scheme allegedly perpetrated by Robert Allen Stanford and the Stanford Financial Group.

“You have to value the clear harm to investors over potential litigation risk,” said David Kotz, inspector-general of the Securities and Exchange Commission, at a Senate Banking Committee hearing on the alleged Stanford fraud scheme. “The SEC has made some changes, but we’d like it to be even more clear in their procedures that the number of investors harmed is the most important consideration.”

Corporate defaults at pre-crisis levels

The SEC has been under intense pressure in recent years for failing to identify the alleged fraud scheme and a $50 billion Ponzi scheme perpetrated by Bernard Madoff in a timely manner.

A 2009 SEC suit claims Stanford and three of his companies defrauded investors in an $8 billion scheme involving certificates of deposit. Yet Kotz pointed out that the SEC’s Washington examination staff identified strong evidence of fraud in 2007 but did nothing about it, and a Fort Worth, Texas regional SEC office was aware since 1997 that Stanford was likely conducting a Ponzi scheme, but no SEC action took place until 12 years later.

Specifically, Kotz argued that during the previous decades the Fort Worth office operated within a broader SEC culture where novel and complex cases such as the Stanford scheme were not encouraged because officials were evaluated by the number of cases they brought. Instead, said Kotz, staff were focused on bringing a number of “quick hit” smaller cases to make their offices appear to be more successful than other offices. He added that even if the intention is there to change that attitude at the SEC, he is not sure if the staff know that statistics are not important.

“We need to make sure that the idea that stats are not important trickles all the way down the line,” he said.

In response, Kotz recommended that the agency should consider the amount of investors affected by a particular fraud scheme – rather than potential litigation issues – when deciding whether to purse a case.

“Certainly, the fact that the Fort Worth office was being graded at how many cases they brought was a metric approach coming from Washington because Washington was pushing that approach,” Kotz said. “They didn’t want to use their resources on the Stanford case because that would have meant they would have to work on it for a year and not have a stat.”

Kotz added that sometimes it is worth it to take a case even if the agency believes they are going to lose. “If the enforcement staff believes there is fraud, the investment community would at least be aware of it as a result of the case.”

However, Robert Khuzami, director of the SEC’s Enforcement Division, argued that he is sending a clear message to the agency’s staff that ‘quick hits’ small cases should not be weighed more heavily than bigger cases. He pointed out that the agency has brought major, complex cases against major companies, including Dell Inc.
DELL
, Citigroup Inc.
C, -1.01%
, Goldman Sachs Group Inc.
GS, -0.73%
and even WorldCom and Enron, in the past. In July, Dell, Citi and Goldman each settled with the SEC on various charges, paying between $75 million and $550 million each.

“We are not getting quick stats on those cases,” Khuzami said. “[Quick hits] are not the standard today, I assure you.”

He argued that the shortcoming at the agency occurred with Stanford because the agency didn’t respond as creatively as it could to the case. He also refuted Kotz’s assertion that sometimes the agency should take cases even if they believe they will lose.

“The shortcoming occurred because there wasn’t sufficient follow-up to get as much evidence as we could have,” Khuzami said. “But if we go and lose a case, the perpetrators can use that as a Good Housekeeping seal of approval and you have to be concerned about that.”

He added that such a case would not happen again today.

“There is much more collaboration on these issues,” he said.

Senators take issue with agency’s handling of Stanford

Lawmakers also expressed concern about the agency’s handling of the Stanford case. Senate Banking Committee Chairman Christopher Dodd (D., Conn) argued that the SEC finally took action in the Stanford case only after Madoff’s own Ponzi scheme was exposed.

“We seem to have an instance in which one side of the agency was screaming that there was a fire, and the other side said that the fire was too hard to put out or not a fire at all.”

Steps taken

Khuzami added that the agency has taken a number of actions in response to recommendations made by Kotz.

In response to the July 2009 report, the SEC has taken new steps to evaluate potential harm to investors when deciding to bring an enforcement action, said Khuzami.

He added that the agency has also implemented new performance evaluation procedures for agency staff and improved coordination between the enforcement division and the Office of Compliance Inspections and Examinations, which reviews corporate filings.

The agency, Khuzami said, has set up an Office of Market Intelligence which will collect tips, complaints and referrals in one place and makes sure the compliance division’s referrals to the enforcement division are given to the appropriate staff.

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